P2P Lending Double Whammy – SEC and Credit Crunch

Peer-to-peer lending sites like British-based Zopa are starting to reflect the weakness cutting through the global economy. Their U.S. operations will now be handed over directly to their Credit Union partners, rather than remain as the intermediary (their Italian and UK operations remain). Regulations had forced them into a partnership with these Credit Unions, as opposed to sites like Prosper, which bill themselves as pure P2P lending plays. Zopa attributes their hardship due to tighter credit markets.

P2P lending involves borrowing and lending between participants without the use of traditional financial channels. This is a flagship example of how Wikinomics (and the Internet in general) is fostering a “disintermediation” trend, stripping down marketing and distribution channels. To be fair, P2P lending marketplaces are a version of “disintermediation-lite”, as they do broker transactions, and add a layer between counterparties.

U.S.-based lending firms have also been feeling the squeeze, as they say default rates creep higher and return-on-investment drops for lenders taking the plunge. I did some surfing on LendingStats, a visualization site that feeds from Prosper’s open data feed. I went in expecting to see delinquency rates rise when comparing YTD 2008 with the same period in 2007, and it turns out delinquency rates have dropped markedly. For YTD 2008, 615 of 11,542 loans on Prosper (5.3%) are delinquent (late or defaulted). The same period in 2007 the delinquency rate was 2,429 of 9,356 loans (25.9%). Big difference. So what’s the deal? Seems contrary to what most of us expect.

So I took a look at the average amount per delinquent account between years, and 2008′s average is around $5,800 and 2007 is around $7,400. So not only is the proportion of defaulters dropping, but so is the average amount of the delinquency.

The only thing I could glean from the data that seems consistent with the Big Banks’ experiences was that the average credit score of the delinquent pool is getting better. In other words, people with better credit scores are delinquent more on average than last year (average delinquent score 4.55 in 2008 versus 5.04, lower is better)

[I must disclaim: The figures from LendingStats are on an average basis, and as such may not be as accurate as would be a dollar-weighted measure of credit score etc. But I thought it interesting nonetheless. ]

Where the SEC fits in is that it’s reviewing requests by Prosper and Lending Club to allow a secondary market for the P2P loans arranged through their site. In other words, it will create a marketplace where lenders can sell their loans to others. This reselling scheme smacks like what got us into hot water with mortgage-backed securities, but I guess the trouble will only start if loans are bundled together into a jumbled mess and sold off tranche by tranche. The size of the marketplace probably makes transparency easier—for now. Perhaps some readers have some insight as to whether this is a good idea or not, or the likelihood of history repeating in the P2P market.

Also, I wanted to post another question to the Wikinomics Community: are we getting away from what made P2P work? Many think that it was the personal aspect of P2P that turned people on to it, a welcome change from the rubber-stamp mortgage managers at your local branch. Could a secondary marketplace promote detachment, where the loan buyer doesn’t care (or know) that his $500 is helping Joe the Plumber get his plumber’s license?

Maybe I’m just too sentimental.

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If its ok, here is some background data that will both clarify, and generate some new questions.

1. Zopa, LendingClub and Prosper are all subject to the same regulations in US. The primary regulator is the SEC and the governing regulations are securities. This reflects the apparent fact that online display of a loan request for purposes of investing in that loan request, is a security.

2. LendingClub filed an S-1 in June, and re-opened October following SEC approval. Prosper went ‘quiet’ in October, accepting no more lenders, pending S-1 filing and approval. Note that the LendingClub approval contains conditions that restricts lenders to those who are financial savvy, and capabale of sustaining losses.

3. Prosper altered their policy Feb 2007, and elminated low credit scores, below 550 +/-. Their earlier policy of accepting any borrower notwithstanding their score was unworkable – ie there is a point where the certainty of loss is so high, that no interest rate can ever compensate for the risk.

End of facts – rest is my view:

3. Disintermediation: social lending eliminates the traditional middleman so qualifies on that alone. It further qualifies based on the fact that the social lender is passive in the transaction, serving only the platform to enable the transaction.

disclosure: I am active with CommunityLend, a Canadian social lender who is seeking regulatory approval prior to launching.

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